Newt Gingrich and Peter Ferrara propose cutting middle-class income taxes. People now paying at the 25 percent tax rate would, under their reform, pay 15 percent instead. Unlike Obama’s middle-class tax cuts, they argue, their proposal would improve incentives to work and invest.
Conservatives ought to be in favor of middle-class tax relief. But we can do better than this proposal.
First of all, the vast majority of tax filers don’t hit the 25 percent tax bracket, so this proposal is upper-middle-class tax relief at best.
Second, keep in mind that it is not just the middle class that pays the 25 percent rate. Under our tax code, a couple is in the top tax bracket, for example, pays 10 percent on its income up to $16,000, 15 percent on the next chunk of income up to $65,000, 25 percent on income up to $131,000, and so on. What this means is that most of the money that the 25 percent tax rate raises for the federal government is not taxed at the margin. Cutting that rate will lower tax payments for many affluent people without changing their incentives at all. For them, the tax-rate cut has the same effect as giving them a tax credit. The federal government would lose a lot of revenue without much reducing the tax code’s distortion of American life.
A larger tax credit for children, on the other hand, would increase the incentive to invest in children; and it would make the federal government less redistributive, since households with children would no longer be (on net) subsidizing those without, as they do today through Social Security and Medicare.